It’s the most important financial headline of this century: Inflation!
A new generation of Americans is about to face the impact of inflation – on their daily lives, their financial decisions, their investment choices, and their retirement lifestyle. While many pundits proclaim that this period of inflation will come to a quick end, history shows that inflation has always ended not with a whimper, but with a bang.

Once started, the fires of inflation are not easily tamped down. Whether in Germany in the 1930s or in Zimbabwe a decade ago (their trillion-dollar note became worthless!) or in the United States in the late 1970s, it has taken a ruthless hand to stamp out the persistent belief that prices would go higher.
It’s important to understand what inflation is—and isn’t, what causes it, what “cures” it –- and the potential impact on your life.

What IS Inflation?
The late, great Nobel laureate Milton Friedman clearly established that inflation is always a monetary phenomenon. It may show up as higher prices, but the root cause is excessive money creation. The fear of declining value of the currency leads sensible people to exchange their money for goods and services before prices rise again. The cycle is exacerbated by workers demanding higher wages to “keep up” with inflation, thereby driving the cost of everything still higher.

We may point to shortages because of supply chain disruptions or the war in Ukraine and its impact on energy prices as contributing factors. But if governments—ours and in Europe – had not created so much new “liquidity” (a euphemism for money printing in this digital age) to fight the impact of the pandemic, there wouldn’t be excess money in the system to push prices higher. People would suffer and stop buying. And with lack of demand, prices would eventually come down. But not without pain. That’s Econ 101.

Lessons of History
History tells us the only way to stop inflation is to slow the economic demand by slowing the economy. That slowdown comes from raising interest rates. Paul Volcker had the determination and discipline to do that in the early 1980s. And it cost then-President Jimmy Carter the election (along with other factors). As Fed chairman, Volcker pushed the prime lending rate to 21%. Mortgage rates jumped to over 15%. And the economy moved into a steep recession. It worked – but not without pain.

So that’s what policymakers face now. Jerome Powell tried to wish inflation away by pronouncing it transitory. But as of this writing, the Fed has still not started to withdraw liquidity from the economy by selling its bond portfolio. Interest rates remain historically low. And inflation is roaring.

The longer the Fed waits, the more likely we will see double-digit inflation in the coming months. In an election year.

And even if the Fed moves soon and more strongly than expected, policy always works with a lag. That means a slowdown (recession?) would come at exactly the wrong time – at election time!
Will Powell have Volker’s guts to ignore politics and act strongly and immediately? That is the big question. But make no mistake: either way there will be pain.

The Impact of Inflation
As consumers, we note the impact of inflation in rising prices of everything from filling up a tank of gas to buying groceries. It started with rising housing prices, making homeowners feel richer. But selling and taking gains, leads to the question of where to go. Even rents are rising sharply, reflecting the costs of construction and wages. As mortgage rates move higher, buyers are frozen out of the market and sellers will be stuck in place. That’s the recipe for a housing slowdown. And less spending on furnishing new houses, will add to an economic slowdown.

Plus, there’s more to come. Ukraine is Europe’s breadbasket — and harvests this year are predicted to be from 20- 40% lower this year, while their export ports are blocked. Shortages can only lead to higher food prices — and even hunger.

Is there any place to hide and protect your assets during a period of high inflation?

For retirees living on fixed income and Social Security, this coming period of inflation – however long it lasts—will be devastating. For 2022, Social Security checks jumped an astounding 5.9% (though impacted by higher Medicare premiums). The latest predictions suggest an 8.9% increase in Social Security checks for 2023. But likely that still won’t keep up with increased costs in everything from rents to food.

Stocks have always been a good hedge against inflation—over the long run. In fact, according to Ibbotson market historians, there has never been a 2—year period in the last 100 years where stocks didn’t outperform inflation. But those periods included deep market declines. Those close to retirement might panic if they need to withdraw money from their retirement accounts in a temporary market decline, perhaps caused by higher interest rates.

Keeping some cash on the sidelines creates an obvious risk. Buying power of cash is destroyed by inflation – unless interest rates keep up. And that’s not happening, since the system is so flooded with liquidity that banks have no incentive to raise rates and attract deposits. With the inflation uncertainty, banks are reluctant to lend.

Still, if you need cash for living expenses, it might be worth taking the inflation hit to have some immediate liquidity, so you’re not forced to sell stocks at a loss for required withdrawals. Free market savings rates will rise – -eventually.

According to the Rule of 72, divide any number into 72 and the result will be the number of years it will take for the value to be cut in half. Thus, 3% inflation cuts your spending power in half in 24 years. But 8% inflation cuts your spending power in half in less than 10 years!!

So much for choosing an immediate annuity with a lifetime payout that looks good today. Thank goodness, Social Security adds an inflation adjustment. (Wait to take benefits and start with a higher base check to get more money in those annual adjustments!)

Bonds can be devastated by inflation, as I’ve often written. (Search my columns for “Beware of Bonds.”) Who wants your old 3% -20-year bond if inflation rages much higher? Try to sell and you’ll lose money since no one will give you that $1000 face value for an old-low-rate bond, even from a great company. If you don’t sell and take the loss, you’re stuck earning less.

If you need to own bonds, at least own TIPS – Treasury Inflation Adjusted bonds – easily found in mutual funds from major companies. Warning: Only buy TIPS inside a retirement account. Otherwise you will be taxed on the unrealized appreciation every year.

Gold might be old-fashioned, but it has awakened from its long sleep as an inflation protector, now approaching the $2,000 mark. For those who thought crypto was the new gold, perhaps think again. It didn’t help Russia avoid sanctions. It hasn’t been hidden from governments, per the recent seizures of crypto assets taken in frauds. Digital might be the wave of the future, but at present it has not been an escape from governments that would degrade their currencies.

Series I Savings Bonds have become the go-to inflation beating investment. Currently they carry a 7.12% rate, which will be adjusted every 6 months in May and November to match inflation. Expect the May 1st adjustment to be higher. Sadly, there is a limitation of $10,000 per year on individual purchases of these digital savings bonds purchased through TreasuryDirect.gov. A reminder, you must hold them at least one year. And if you sell before holding for 5 years, there is a penalty of 3 months loss of interest.

Commodities –everything from energy to soybeans—are rising in the face of inflation expectations. You can hedge by using ETFs that track commodity prices, but be warned that these are volatile investments.

The Outlook for Inflation
There’s a wide range of estimates on Wall Street for how high inflation will go, and how sharply the Fed will act, and whether those actions will trigger a recession. There are no perfect answers. In a worst-case scenario we could have the worst of BOTH worlds: high inflation and an economic slowdown. Expect to hear more about the word STAGFLATION.

And if the economy does slow, we will likely see the return of the “Misery Index” – calculated by adding the unemployment rate and the inflation rate. Surely the Fed does not want to see that!

The U.S. dollar is the world’s reserve currency, reflecting the underlying strength of our economy. This is not the end of the dollar or Armageddon for our nation. But times will be turbulent – and few have any memory of the impact of inflation on the public psyche — and on the markets.

You’re smart. This inflation is not transitory. And it will not end without pain. Be diversified. Stay on top of your entire financial situation. Adjust your lifestyle to prepare. No inflation in the past has been contained without pain. I sincerely hope that “this time it’s different.” But hope is not a financial plan.
And that’s The Savage Truth!

(This post is being sent to newsletter subscribers and will — in shorter form — be my column for next week.)